Transcript Ozman2

Agent Based Computational
Economics
Example:
Network Formation and Strategic Firm Behaviour to Explore and Exploit
Müge Özman
Institut Telecom
Telecom & Management SudParis
DIMETIC 2009 Strasbourg
Agent Based Computational
Systems
Question: How could the decentralized local interactions of
heterogeneous autonomous agents generate the given
regularity?
 Heterogeneity
 Autonomy
 Explicit Space
 Local Interactions
 Bounded Rationality
Experiment: Situate an initial population of autonomous
heterogeneous agents in a relevant spatial environment;
allow them to interact according to simple local rules, and
thereby generate—or “grow”—the macroscopic regularity
from the bottom up.
Background

External interactions of a firm are vital for its competitive advantage.

Main incentive to form external linkages is organizational learning.

Powell et al. (1996): firms network with each other because they explore and
exploit knowledge bases.

Exploration refers to experimentation with new alternatives and
Exploitation "exercise of refinement and extension of existing competencies,
technologies and paradigms" (March, 1991: 85).


Which one? whether a firm collaborates for the purpose of exploring or
exploiting depends on the external conditions (Rowley et al., 2000; Burt, 1998)
Background

Firms in turbulent environments benefit more from exploring knowledge,
while firms in more stable environments prefer to deepen their existing
knowledge through their external contacts (Rowley et al., 2000).

Proponents of the social capital view (Coleman, 1988) argue that, taking
place in dense networks with embedded relations (Granovetter, 1985) in
which interactions are accompanied with thick knowledge exchange,
and which are frequent and face to face, helps to build trust among the
parties, Networks rich in social capital facilitate transfer of tacit
knowledge since a common language is developed among the parties.
Better for exploiting knowledge.
Background

Inspired from Granovetter's leading arguments on the strength of weak
ties (Granovetter, 1973), proponents of structural holes argue that
networks rich in social capital result in redundancy of knowledge exchange,
since the same parties interact frequently. As they argue, firms should fill
structural holes in the network, and act as "bridges" connecting otherwise
disconnected clusters of firms (Burt, 1992). These weak ties are advantageous
in terms of getting access to novel knowledge from diverse sources, thus
beneficial for exploration purposes and when the knowledge being
transferred is more codified (Rowley et al. 2000). It is argued that
especially in technologically turbulent environments, a firms' access to
novel knowledge is critical for competitive advantage.
Question



Overall network structure among firms in an industry depends on the industrial
conditions.
This is because under different conditions of the industry firms have different
motivations to construct external linkages.
What are the characteristics of the overall network structure when firms
individually select other firms under different conditions of the industry?
Method



Because many firms select partners in a decentralised manner based on their own
self interest, the overall structure of networks that emerge cannot be predicted a
priori.
An agent-based simulation model is a promising avenue to explore the overall
consequences of individual decisions, and how the macro structure of the
network emerges from the micro decisions of each firm in the industry.
In defining industrial conditions, focus on three dimensions as turbulence,
tacitness of knowledge and technological opportunities.
The Model




Firms construct external linkages for the purpose of organizational learning, in
the form of exploration or exploitation;
In stable environments firms are willing to exploit, and firms in turbulent
environments are willing to explore (Rowley et al., 2000);
Constructing strong ties is better for exploiting knowledge, and constructing
weak ties is better for exploring new knowledge (Rowley et al., 2000);
As knowledge becomes more and more tacit, a firm needs to interact more
frequently with geographically close firms (i.e. strong ties) to increase its extent
of learning (Cowan et al., 2004; Audretcsh and Feldman, 1996; Uzzi, 1997).
I: Selection of Partners

Mathematically, when ego firm i is choosing among other firms, he assigns the
following value to an interaction with firm j
Value that firm i assigns to its collaboration with j
Error term
Knowledge level of firm j
Number of times i and j have met in the past
Distance between firms i and j
I: Selection of Partners
• In stable environments firms
willing to exploit, and in
turbulent environments willing
to explore
•strong ties better for exploiting
knowledge, and weak ties better
for exploring new knowledge
•As knowledge becomes more
tacit, a firm needs to interact
more frequently with
geographically close firms
I: Selection of Partners

As the absolute value of a gets smaller acquiring the same level of benefit from a
collaboration requires more meetings and/or shorter distance. This refers to the
case where knowledge becomes more tacit. Therefore, as a gets smaller, the
tacitness of knowledge increases in the model.

Change in the slope: As the absolute value of a gets smaller, the slope of the
curve decreases. The marginal value of past meetings over distance falls. For an
ego firm, this means that there is very little difference in terms of
expected value, of connecting to an immediate neighbour, or else the
one next to the immediate neighbour, because in any case knowledge
transfer is far too limited in both cases.
I: Selection of Partners


The sign of a:
(+) Exploration, turbulent environment
(-) Exploitation, stable environment
The magnitude of a :
Increased tacitness in both regimes.

In the first stage of the model, every firm selects a partner by choosing the one to
whom it has attributed the highest value by Eq.1, and firms interact. In each
period each firm contacts another firm A firm may have contact with many other
firms, if it is selected by them.
II: Diffusion
II: Diffusion


After partners are selected, the firms learn from each other, their knowledge
levels are updated. Technological opportunities in the industry determine the
amount of learning.
Learning function for firm i, from its interaction with firm j:
II: Diffusion

Relative knowledge levels before and after learning (Cowan et al., 2004)
II: Diffusion
A Summary of the Simulation Model






In period t=0, the initial knowledge levels of firms and parameter values are set.
In the beginning of the period, each firm assigns to every other firm an expected
value of collaboration using Eq.1.
Next each firm forms a connection to the firm which it has assigned the highest
value. In this way a network forms and it is recorded. In this scheme, each firm
selects one partner. But some firms might be selected by many other firms.
After selection of partners, firms learn from their neighbours. via Eq. 2.
Knowledge levels of the firms are updated, which marks the end of the period.
Links are deleted, and the second period begins with the updated knowledge
levels. The same loop is repeated.
After sufficient periods elapse, the frequency matrix is obtained and the
simulation run ends. The parameter values are changed, new knowledge levels are
assigned, and another simulation run begins as described above.
Parameters






N=30 firms, located on a circle.
Each firm i is endowed with a knowledge scalar, ki assigned randomly at period
t=0; shows the level of firm i's knowledge.
The main parameters:
 α:the industry regime (α<0 for exploitation regime and α>0 for
exploration regime), and tacitness of knowledge (smaller values connote
higher tacitness) and
 γ which measures technological opportunities.
We look at measures of network structure under the parameter space defined by
α and γ.
One simulation run consists of 1000 periods. At the end of the 1000 periods,
record frequency matrices,
10 simulations for each of the parameter combinations, results correspond to the
average of network measures.
Network Analysis:
Spatial Strength, Degree Centrality, Reachability

Measure the extent to which firms in the network form strong ties. As we use the term,
strength of a tie has two dimensions;


extent to which the tie is constructed with a geographically close firm, and
the number of times the tie is repeated between two firms.

For this purpose, the spatial strength index measures the extent to which they interact
frequently with close neighbours.

Higher values of the spatial strength index reflect the tendency in the population to
form strong ties with close firms. Lower values of the index reflect a tendency to form weak
ties with distant firms.
Results I: Spatial Strength
Results II: Degree Centrality
Reachability
Results
Exploitation Regime
Results
Exploitation Regime
WHY? Interpretation of Results
Exploitation Regime

(1) As tacitness increases, SSI falls. Is a consequence of functional form, which
states that the difference between connecting to an immediate neighbour, or
else connecting to a firm in the vicinity is lower as tacitness increases. As
expected, this creates a loosening of the connections towards more distant
partners, which reduces strength of ties.

(2) when knowledge is relatively codified, higher technological opportunities
generate "local stars", whereas as knowledge becomes more tacit, higher
technological opportunities generate "global" stars.
WHY? Interpretation of Results
Exploitation Regime






There are two forces working in opposite directions: KNOWLEDGE EFFECT
and HISTORY EFFECT
The network structure that emerges is a result of the effect that dominates.
When an ego firm is selecting partners, he can take into account the partner's
knowledge level, and also their history and distance
If knowledge effect dominates, firms care less about their history and distance,
but more about the knowledge of the partner and we see loosening of
localization.
For example, when knowledge of the potential partner is too high, he becomes
too attractive to be ignored for the ego firm, so instead of commitment to
making strong ties with close firms, he can select the star firm.
If history effect dominates, firms care more about forming strong ties with
close neighbours, regardless of their knowledge level.
Exploitation:
Codified Knowledge and High Technological Opportunities:
Local Stars






When knowledge is relatively codified, history effect is more dominant so firms have a
tendency to form strong ties with close partners.
As technological opportunities increase firms have more chances to leapfrog their
partners, provided that their relative knowledge levels are close.
In this case, some lucky firms have neighbours whose knowledge levels are close to
themselves. These firms can easily leapfrog their partners, and they have more chances to
innovate.
They become more attractive for the other firms in the vicinity. In other words, having a
firm around whose knowledge becomes significantly higher than others attracts other
firms to the star firm.
For these peripheral firms, this is the case where the knowledge effect starts dominating
the history effect, because there is a firm in the vicinity whose knowledge is too big to
ignore.
Because transfer of knowledge is easier when knowledge is codified, the knowledge gap
between peripheral firms and the star firm does not grow too much. Therefore star firms
always remain as the local stars, without being able to extend their field of attraction to all
the network.
Exploitation:
Tacit Knowledge and High Technological Opportunities:
Global Stars







As knowledge becomes more and more tacit, losening effect of strong ties.
In this case, history effect is not so strong, knowledge effect can dominate.
Therefore firms will have a tendency to prefer knowledgeable partners to
forming strong ties with close neighbours.
However, in this case knowledge is relatively more difficult to transfer.
Some lucky firms who have neighbours with similar knowledge levels in the
vicinity start innovating.
This time, however, because it is relatively difficult to transfer knowledge, the gap
between these firms and peripheral firms keeps increasing and peripheral firms
fall further behind.
This is how some firms become more and more attractive, and extend their field
of attraction to other firms in the network, and eventually they become "global"
stars.
WHY? Interpretation of Results
Exploration Regime





In an exploration regime, firms want to meet new and distant firms to
be informed about knowledge residing elsewhere in the network other
than in close vicinity.
higher technological opportunities and knowledge tacitness increase
centrality
The main difference between the exploration and exploitation regimes
in terms of networks is that, in the former case networks are denser,
and thus spatial strength index is lower
Contrary to the exploitation case, here the dilemma that a firm faces is
whether to connect weakly to a distant firm and have access to novelty,
or to connect to highly competent firms.
Because there are no increasing returns from repeated interactions,
firms can now select both options. This is why the spatial strength
index is very low, and the reachability of the network is one in an
exploration regime.
WHY? Interpretation of Results
Exploration Regime







One interesting result in this regime is that when technological
opportunities are high, network centrality is higher.
There are some firms who benefit from their distant connections more
than other firms because of relative knowledge levels. This gives them
more chances to innovate.
In this way, they become more attractive to other members of the
network.
When knowledge is codified, its transfer is easier, so overall
knowledge differences among the firms do not grow too much.
As knowledge gets more and more tacit, star firms strengthen their
position in the network, because their knowledge easily exceeds that
of other firms.
In other words, only these firms can make use of technological
opportunities in the industry while others are attracted to them
without being able to learn too much and by falling further behind
In this way, higher tacitness and technological opportunities generate
stars in the industry
Summary of Results

In a world where we can distinguish between two regimes as an
exploitation regime and an exploration regime, different network
structures emerge depending on technological opportunities and
extent of tacitness of knowledge.

In an exploitation regime, high technological opportunities and
codified knowledge result in the emergence of local star firms. When
knowledge gets more tacit, local stars become global stars in the
network who are more competent than other firms.
Our results imply that in an exploitation regime, firms who are similar
to each other in terms of their knowledge level should be in the same
vicinity to capture the most of technological opportunities.
